Friday, September 23, 2011

This week's market swoon improved equity market valuations that were already attractive. The 12-mo. trailing PE of the S&P 500, according to Bloomberg, is now around 12.5, well below its 50-yr average of 16.6. On an earnings basis, equities are now yielding around 8%, much higher than the 5% yield on BAA corporate bonds, according to Moody's.

The only logical explanation for why valuations are so attractive is that the market fully expects a significant deterioration in corporate earnings in the years to come. Again, my point is that the market is priced to some very pessimistic assumptions. If things don't turn out to be as bad as the market now expects, then there is plenty of upside left in the stock market.

3 comments:

i have become much more bearish as i watch the european financial situation unfold. they have a huge collective action problem over in europe, and any response to a financial tumult has to be strong and coordinated. i see nothing like that out of the europeans, and i doubt that any fallout would be "manageable" for the US markets. i just don't think you can reliably use old saws like the earnings yield/trsy yield model at times of stress like we have now.